The recent case Espinoza v. Zuckerberg proves even the powerful have to follow the rules. In a case of first impression the Delaware Chancery Court addressed the question:
Can a disinterested controlling stockholder ratify a transaction approved by an interested board of directors, so as to shift the standard of review from entire fairness to the business judgment presumption, by expressing assent to the transaction informally without using one of the methods the Delaware General Corporation Law prescribes to take stockholder action?
The Facts in Brief
In August, the board of directors of Facebook meet and voted to increase the compensation paid to members of its audit committee. Plaintiff Espinoza filed a derivative complaint challenging the decision to increase compensation as breach of fiduciary duty “for awarding and/or receiving excessive compensation at the expense of the Company,” a waste of corporate assets, and unjust enrichment.
When the suit was filed the parties agreed that although the compensation committee had discussed the matter, the approval was given by the board and therefore would be governed by the entire fairness standard of review as a self-dealing transaction. After the filing, Mark Zuckerberg, who did not receive any of the disputed 2013 compensation and who controlled over 61% of the voting power of Facebook’s common stock, expressed his approval of the 2013 compensation for the non-management directors in a deposition and an affidavit.
Defendants then sought summary judgment on the theory that Zuckerberg, in his capacity as a disinterested stockholder, ratified the 2013 compensation, thereby shifting the standard of review governing that transaction from entire fairness to the business judgment presumption. Defendants also seek to dismiss the waste claim for failure to state a claim upon which relief can be granted.
As stated by the court “The fundamental issue here is whether Zuckerberg’s approvals were in a form sufficient to constitute stockholder ratification” when “Zuckerberg did not make use of a formal method of expressing stockholder assent, namely by voting at a stockholder meeting or acting by written consent in compliance with Section 228 of the Delaware General Corporation Law.”
Defendants argued that informal ratification by the controlling shareholder was sufficient, relying on general principals of agency law.
After walking through the history of what is now Section 228 of the Delaware General Corp. Law, the court concluded that formalities must be followed for shareholder action by written consent to be valid, noting:
- the provisions of the DGCL governing the ability of stockholders to take action, whether by voting at a meeting or by written consent, demonstrate the importance of ensuring precision, both in defining the exact nature of the corporate action to be authorized, and in verifying that the requirements for taking such an action are met, including that the transaction received enough votes to be effective. They also demonstrate the importance of providing transparency to stockholders, whose rights are affected by the actions of the majority. In particular, stockholders have the right to participate in a meeting at which a vote is to be taken after receiving notice and all material information or, in the case of action taken by written consent, to receive prompt notice after the fact of the action taken.
- where formal structures govern the collective decision-making of stockholders who coexist as principals.,,,,[t]hese formalities serve to protect the corporation and all of its stockholders by ensuring precision, both in defining what action has been taken and establishing that the requisite number of stockholders approved such action
Finally, the court dismissed the motion for summary judgement on all but the waste claim, stating:
- I therefore conclude that stockholders of a Delaware corporation—even a single controlling stockholder— cannot ratify an interested board’s decisions without adhering to the corporate formalities specified in the Delaware General Corporation Law for taking stockholder action.
Consequently, neither Zuckerberg’s affidavit nor his deposition testimony ratified the Facebook board’s decision to approve the 2013 Compensation, which decision remains subject to entire fairness review because a majority of the board was personally interested in that transaction. The entire fairness standard of review requires defendants to establish that the “transaction was the product of both fair dealing and fair price.” Because defendants relied solely on a ratification defense, they did not attempt to produce evidence of entire fairness sufficient to show an entitlement to judgment as a matter of law, nor have they demonstrated that there is no genuine issue of material fact as to the entire fairness of the 2013 Compensation.
What to make of this case? As we know from piercing cases, formalities matter. Even the rich and powerful must pay attention.